Gross wants Treasuries north of 4%

Bill Gross doesn’t much like Treasury bonds now, but it’s not because he’s banking on a U.S. downgrade.

Gross is the globetrotting bond manager whose decision to empty his Pimco Total Return fund of U.S. government debt was the talk of the markets this week.

But appearing on Bloomberg television Friday, Gross said he isn’t necessarily expecting the worst for the U.S. economy – only that he believes the risk-reward profile on a 3.4% 10-year Treasury note is none too good at a time when the Fed is promising to whip up inflation.

It is a question of valuation. The U.S. government is a AAA credit — will be a AAA credit for some time going forward. It is not a question of departing Treasuries based on credit fears. It is simply a reflection of the value of Treasuries relative to other sovereigns or corporate bonds or other issues in the marketplace.

That is to say, Gross will want to see Treasuries yielding more than they are now before he buys them. How much more?

If nominal GDP is in the 4-5% range going forward for the next 12 to 18 months which is in the Fed’s forecast, then 10-year treasuries should be rewarding investors with a 4% type of yield. We are being under rewarded now at 3.5%. Let’s move into other markets is Pimco’s favored type of direction. Let’s look at other sovereigns with higher yields and corporate bonds that have not been subject to the QE2 types of policies which have lowered interest rates artificially.